11 April 2013

Impact of Regulation and Competition on Electricity Tariff (Then and Now)

Energy Market Authority recently commented on the relationship between low tension electricity tariffs and fuel prices.[1]

"Since the electricity market was liberalised in April 2001, the EMA has applied both regulation and market competition to incentivise the industry to reduce costs and achieve higher efficiencies.

"While inflation from 2001 to this year has exceeded 30 per cent cumulatively, grid charges have fallen by 14 per cent.  In addition, electricity tariffs have increased by 34 per cent during that period, compared with a 220 per cent increase in fuel prices.

"As fuel costs make up more than half of the tariff, a 220 per cent rise in fuel prices would translate into the tariff increasing by more than 100 per cent if there were no efficiency gains from regulation and market competition."

Wrong Maths
EMA got its maths wrong.  (Readers may skip the next four paragraphs if they wish.)

Let's assume fuel costs account for 55 per cent of the current low tension electricity tariff, which is a fair estimate based on a fuel oil price of $122.55 per barrel.

If fuel prices increase 220 per cent over a future period (e.g., from today to 2025) and nothing else changes, the tariff will increase 121 per cent over the same period.  However, by the end of the period, fuel costs will account for 80 per cent of the tariff, up from 55 per cent today.[2]

If fuel prices had increased 220 per cent over a past period (e.g., from 2001 to today) and nothing else had changed, the tariff would have increased 61 per cent over the same period.  However, at the beginning of the period, fuel costs would have accounted for 28 per cent of the tariff, compared to 55 per cent today.[2]

EMA made the mistake of using the increase of 220 per cent in fuel price from 2001 with today's fuel-cost-to-tariff ratio, instead of the fuel-cost-to-tariff ratio in 2001.[2]

Let's correct EMA's statement as follows:

"As fuel prices had increased 220 per cent since 2001, the tariff would have increased 61 per cent if nothing else had changed, in particular, if there were no efficiency gains from regulation and market competition.  However, the tariff increased only 34 per cent."

Although less spectacular than 100 per cent, the 61 per cent increase is almost double the 34 per cent actual increase in the tariff.

Why did the tariff increase 34 per cent since 2001, instead of 61 per cent?

Tariff Components
By way of background, the low tension tariff comprises the following components:

Component

Paid To
% Q2 2013 Tariff
Energy cost comprising:
▪ Fuel cost
▪ Non-fuel cost
Electricity generation companies
80.3%
Network cost SP PowerAssets
18.9%
Market support services SP Services
  0.6%
Market administration and power system administration fee Energy Market Company and power system operator (a division of EMA)
  0.2%

Thermal Efficiency and Reserve Costs
With the commencement of National Electricity Market of Singapore in 2003, combined cycle gas turbines became the dominant source of generation, displacing oil-fired steam turbines.  Combined cycle gas turbines provide superior fuel efficiency and environmental performance compared to steam turbines.[3]

The computation and allocation of reserve costs were also changed so as not to discourage high capacity combined cycle gas turbines from generating at efficient levels for fear of attracting disproportionately high reserve costs.[3]

Market Competition
If competition restrained tariff increases in recent years, does it mean that tariffs could have been lower in the past but for the lack of competition?  Does it mean that the generation companies earned good profits in the past?

The main generation companies in the early 2000s were:

▪ Senoko Power, which had a market share of more than 30 per cent.[4]

▪ Power Seraya, which had a market share of more than 27 per cent.[5]

▪ Tuas Power, which had a market share of 25 per cent.[6]

All three companies were owned by Temasek Holdings prior to their being sold in 2008.

As for the national power grid, it was (and still is) owned by SP PowerAssets, the ultimate parent of which is Temasek Holdings.

Network/Grid Charge and Inflation
According to EMA, despite inflation since 2001 exceeding 30 per cent cumulatively, grid charges fell 14 per cent.

Presumably, EMA was referring to Consumer Price Index inflation.  But it is not an appropriate inflation index.  Food, housing and transport prices and inflation have little to do with national power grid prices.

A more relevant inflation index is Domestic Supply Price Index.  Let's look at the machinery and transport equipment sub-index and some of its components:[7]

Item

2001
2011
% change
Machinery and transport equipment
119.0
80.4
-32.4%
Machinery excl. transport equipment
120.1
79.6
-33.7%
Power generating equipment
108.4
107.6
-0.7%
Industrial machinery
105.2
79.3
-24.6%
General industrial machinery
100.6
98.9
-1.7%
Electrical machinery n.e.s.
119.2
79.0
-33.7%

The price trend of hardware, which is the main cost component of the grid, is stable if not deflationary.

Network/Grid Charges Collected
Although grid charges (in cents per kWh) fell in recent years, total grid charge (in dollars) did not fall (other than in 2009) because electricity sales have expanded.[7][8][9]

Year
Average Grid Charge
cents / kWh
Electricity Sales
GWh
Total Grid Charge
$ million
2008
5.22
37,940
1,979
2009
4.92
37,947
1,868
2010
4.92
41,200
2,027
2011
4.82
41,787
2,012
2012
4.78
42,808
2,046

Network/Grid Charge Increased
The network charge was increased in Q3 2013 by 0.27 cents per kWh to 5.05 cents per kWh, or 5.6 per cent.  Based on electricity sales in 2012, this will generate additional annual grid charges of $116 million.

The increase in grid charge was for additional infrastructure investment to meet increased demand and replace ageing assets, according to SP Services.[8]

Typically, companies pay for their infrastructure investment and recover depreciation expense and funding costs together with other overhead costs through usage charges (e.g., grid charge in the case of SP PowerAssets); customers are not asked to pay for the companies' infrastructure investment.

If additional infrastructure investment is needed to meet increased demand, wouldn't this increased demand generate sufficient grid charges to offset the depreciation of the additional investment over the next several decades?

As for the cost of replacing the ageing assets, this too will be depreciated over the next several decades, and offset by future grid charges.

---------------
Notes

1. ENERGY MARKET AUTHORITY Info on Electricity Tariffs Readily Available Online The Straits Times 6 Apr 2013.

2. The calculations are as follows:

Assumptions (today):
▪ Fuel price: $122.55 per barrel
▪ Fuel cost: 14.69 cents per kWh
▪ Non-fuel cost: 12.02 cents per kWh
▪ Tariff: 26.70 cents per kWh
▪ Fuel cost as percentage of tariff: 55%

Scenario A (2025)
▪ Fuel price: $392.16 per barrel (122.55 x 3.2)
▪ Fuel cost: 46.99 cents per kWh (14.69 x 3.2)
▪ Non-fuel cost: 12.02 cents per kWh (same as today's)
▪ Tariff: 59.01 cents per kWh
▪ Fuel cost as percentage of tariff: 80%

Scenario B (2001):
▪ Fuel price: $38.30 per barrel (122.55 / 3.2)
▪ Fuel cost: 4.59 cents per kWh (14.69 / 3.2)
▪ Non-fuel cost: 12.02 cents per kWh (same as today's)
▪ Tariff: 16.60 cents per kWh (rounding error)
▪ Fuel cost as percentage of tariff: 28%

Actual (2001):
▪ Fuel price: $38.30 per barrel (122.55 / 3.2)
▪ Fuel cost: 4.59 cents per kWh (14.69 / 3.2)
▪ Non-fuel cost: 15.34 cents per kWh (19.93 - 4.59)
▪ Tariff: 19.93 cents per kWh (26.70 / 1.34)
▪ Fuel cost as percentage of tariff: 23%

3. NATIONAL ELECTRICITY MARKET OF SINGAPORE Wholesale Electricity Market Report 2003.

4. TEMASEK HOLDINGS PTE LTD Temasek Sells Senoko Power to Japanese Consortium 5 Sep 2008.
5. TEMASEK HOLDINGS PTE LTD Temasek Sells Power Seraya to YTL Power International for an Enterprise Value of S$3.8 Billion 2 Dec 2008.

6. TEMASEK HOLDINGS PTE LTD Temasek Successfully Completes Divestment of Tuas Power 14 Mar 2008.

7. DEPARTMENT OF STATISTICS Yearbook of Statistics Singapore 2012.  The machinery excluding transport equipment is derived from the data.

8. SP SERVICES Media releases.

9. DEPARTMENT OF STATISTICS Monthly Digest of Statistics Singapore February 2013.

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